Question

20-14 Cable Corporation orally engaged Drake Company, CPAs, to audit its financial statements. Though the financial statements Drake audited included a materially overstated accounts receivable balance, Drake issued an unqualified opinion. Cable used the financial statements to obtain a loan to expand its operations. Cable defaulted on the loan and incurred a substantial loss. If Cable sues Drake for negligence in failing to discover the overstatement, Drake's best defense would be that Drake did not?

1) Have privity of contract with Cable.
2) Sign an engagement letter.
3) Perform the audit recklessly or with an intent to deceive.
4) Violate generally accepted auditing standards in performing the audit.

Answer 1

Drake's best defense against negligence would be to prove that it did not perform the audit recklessly or with an intent to deceive, satisfying generally accepted auditing standards.

Step-by-step explanation:

The student's question is about a potential lawsuit for negligence in an auditing context. If Cable sues Drake for negligence in failing to discover the overstatement in the accounts receivable balance, Drake's best defense would likely be option 3: Drake did not perform the audit recklessly or with an intent to deceive.

This is because auditors have the duty to perform their work following generally accepted auditing standards, and unless there is evidence of recklessness or intent to deceive, proving negligence would be more difficult. Establishing that they did not violate standards typically provides a strong defense. Options 1 and 2 regarding privity of contract and the signing of an engagement letter might not be as strong defenses in this context, especially if the audit was actually carried out. Therefore, the best defense would relate directly to the quality and intention behind the audit work performed.